Wall Street Giants in Crosshairs Over Broker Cash Sweep Accounts

Legal scrutiny is mounting for Wall Street powerhouses including JPMorgan Chase & Co. and Wells Fargo & Co. over allegations they shortchanged millions of clients in their handling of idle cash.

Customers have filed proposed class actions against several big banks and their broker affiliates over “cash sweep” accounts in recent weeks, including an Aug. 28 suit targeting Charles Schwab Corp. The Securities and Exchange Commission is also investigating whether Morgan Stanley, among others, broke federal securities laws.

With a sweep program, uninvested cash in a brokerage account is transferred automatically into a higher-interest account. Numerous brokers stand accused of violating duties to act in the best interest of clients by funneling money to affiliated banks and negotiating one-sided deals that paid customers paltry interest rates.

Robert Jackson, a New York University law professor and former Democratic SEC commissioner during the Trump administration, called it a “trillion-dollar conflict of interest” that has affected retail investors around the country. The cases raise legal questions for courts and regulators, however, including what interest rate customers are entitled to.

“The economics are common sense but the law is actually more complicated than it ought to be,” Jackson said during a webinar last week hosted by Bernstein Litowitz Berger & Grossmann LLP, which is investigating various financial firms over their sweep programs.

Charles Schwab previously called the suit against it a “legally unsound, copycat lawsuit.” Wells Fargo, JPMorgan, and Morgan Stanley declined to comment for this story.

‘Underpaid Billions’

Brokerage firms and affiliate banks make “net interest income” on the difference between the interest paid to customers and the interest the banks earn when loaning the sweep deposits, according to customer lawsuits.

That spread, the customers say, has became more pronounced as the federal funds rate—the rate at which banks lend funds to each other—has risen. As of Aug. 30, that effective rate was 5.33%, up from 2022 when it was as low as .08%.

Customers say they haven’t gotten the benefit of those increases, as the interest rate that firms like Wells Fargo paid to some brokerage customers remained as low as .05%.

Collecting the spread has been profitable, plaintiffs’ lawyers say. A lawsuit filed against Ameriprise Financial Inc. in August alleged it made over $2.5 billion from its cash sweep program last year. UBS Group AG’s Wealth Management Division made almost $7 billion in net interest income, according to a lawsuit last month.

“Investors using cash sweep accounts were underpaid billions of dollars due to the drastically low interest rates paid by banks and investment firms, who profited significantly,” said Adam Wierzbowski, a partner at Bernstein Litowitz.

Lawsuits have been filed against at least eight financial firms since late June, Bloomberg Law found.

Bernstein Litowitz created a task force that is looking into cash sweep practices at various financial institutions. The task force includes Jackson and Edwin Hu, a University of Virginia law professor and former SEC economist.

Legal Questions

Several lawsuits allege the brokers violated their fiduciary duty to customers by steering funds to a related entity. Fiduciary duties are also an area of focus for the SEC in its investigations, lawyers said.

Many of the lawsuits also accuse brokers of breaching contracts that promised clients a reasonable rate of interest. That raises the question of what a reasonable rate should be, lawyers said.

“That’s the fundamental question that regulators are going to have to answer and so will lawyers in front of the courts as we’re trying to get this money back for investors,” Jackson said on the webinar.

Some banks, including Charles Schwab, Citigroup Inc., and Wachovia Corp.—now part of Wells Fargo—previously faced allegations they misled customers over their cash sweep programs. A New York federal judge dismissed the suit in 2009 after finding, in part, customers hadn’t adequately alleged a breach of fiduciary duty.

About a decade later, the SEC approved a rule, Regulation Best Interest, requiring brokers to act in the “best interest” of their clients. The rule has been cited by customers suing the banks, though it’s unclear how it might influence courts.

SEC Concerns

The federal funds rate’s rise likely is a factor in the surge of new lawsuits. Increased scrutiny from the SEC into automatic cash sweep programs has also played a role, attorneys said.

Charles Schwab investment adviser subsidiaries agreed in June 2022 to pay $187 million to settle SEC charges that clients were misled about hidden fees in connection with Schwab’s robo-adviser product, Schwab Intelligent Portfolios.

Other firms, including Morgan Stanley and Wells Fargo, have disclosed in recent months that the SEC was investigating their cash sweep programs.

Along with potential conflicts of interest in cash sweep programs, the agency is also targeting inappropriate advisory fees, low rates of return, and liquidity concerns, said Katten Muchin Rosenman LLP litigation partner Lindsey Smith, who has represented financial services firms in regulatory probes.

The increased scrutiny could prompt changes within firms, including stronger compliance programs and enhanced disclosures, attorneys said. Some firms have already moved to raise the interest rates paid to customers on swept funds.

“The firms want to be able to offer these to their clients but obviously without running afoul of the SEC,” Smith said.